Chapter 2 Practice Question Answers
- 1. Answer: B. Companies issue callable bonds to give themselves the option to redeem the bonds early if interest rates drop. To compensate for the risk that they will be redeemed early, callable bonds generally offer a higher coupon rate to the investor.
- 2. Answer: A. 501(c)(3) organizations are designed for non-private activity. Building a toll road is a private activity, since drivers are charged to use the road. Groups that serve religious, literary, or scientific purposes are all eligible to be 501(c)(3) organizations.
- 3. Answer: B. Since her $125 interest payments are semiannual, that means Julie receives $250 a year in interest. Nominal yield is expressed as a percentage of the principal of the bond, and $250 is 5% of $5,000, so the nominal yield of Julie’s bond is 5%. The price that Julie paid for the bond at discount does not affect nominal yield.
- 4. Answer: A. The putable bond provides Charles with the right to redeem the bond before the maturity date. However, since the interest payment on his bond is higher than the market rate, his wisest choice would be to keep the bond because if he redeems it he will miss out on the higher payments. Callable bonds may be redeemed before maturity by the issuer, but putable bonds may not.
- 5. Answer: B. Municipal bond issuers do not have to publish a prospectus, but they are required to provide disclosure in the form of an official statement. Municipal bonds are usually exempt from taxes at the state level for residents of the state in which the bond is issued, and the bonds are not regulated by the SEC.
- 6. Answer: C. General obligation bonds are commonly backed by ad valorem taxes, and as such, typically require voter approval. Liquor tax is considered a special tax and can be used to back a special tax revenue bond, while a bond backed by lease payments is called a lease revenue bond.
- 7. Answer: B. RANs are issued in advance of revenues to be